How a higher cost of capital could reshape markets, economies

What’s driving bond yields?

Stonehouse takes a multifaceted view of yield drivers now, noting that while high energy prices are a factor in the higher rate environment a fall in energy prices “won’t fix everything.” He notes that the government bond yields that should be most impacted by energy prices would be inflation breakevens, but those bonds have been quite range bound. If energy-driven inflation was the extent of the problem, then longer-dated bonds would see higher breakevens.

Stonehouse says that while energy prices are a factor, high debt levels and strong GDP growth in the United States are significant factors. Real US GDP growth is around three per cent and nominal growth is around six per cent. He adds that this growth is being driven in large part by a large amount of investment and capital expenditure, which tends to drive bond yields higher.

Global bond markets are also contributing. Worsening debt crises in France, the UK, and Japan all contribute to the shape of global bond markets and the yields on key instruments like the US 10-year treasury bond. The fifth factor that Stonehouse identifies is the relatively low starting point for term premium. Despite a big move up in 2022, term premium was not fully normalized until more recently. Now, finally, longer-term yields are moving higher.

The sixth and final factor driving bond yields, Stonehouse says, is the AI buildout. The scale of borrowing now being undertaken by the hyperscaling AI companies has created a competition for capital which has driven up credit and bond yields on the longer end of the curve.

What high rates mean for consumers, businesses, government

Stonehouse explains that this new rise in interest rates is coming as many borrowers who had locked in low rate financing before the end of the pandemic have been forced to refinance. Corporations that issued debt with five and ten year terms are now renewing. Canadian homebuyers are facing renewals from their five-year term loans. Even US homebuyers are forced into higher rate mortgages despite the availability of 30-year fixed term loans, simply by the natural churn and movement of people.